A. Description of the Prior Art
During the last recession, a far greater number of businesses failed than would normally have been expected. Bankruptcies, financial defaults, and foreclosures on property also increased, and bad real estate loans caused an atypically large number of lenders to collapse. If there were obvious ways to increase investment return under conditions of economic stress, most likely those ways would have been uncovered long ago.
Consider real estate, for example. Commercial real estate market activity was at or near a standstill for several years around the start of this decade, beginning in the last recession and continuing for more than a year past the end of the recession. Although excess development of commercial space received great attention in the financial press, there was also a drastic reduction in capital available for real estate equity investment and finance.
Real estate equity capital declined as pension funds reduced or ended commitments of new equity capital to real estate capital markets. Capital for real estate finance declined correspondingly as savings and loan institutions withdrew from commercial real estate lending. Of even greater significance, real estate lending practices of insurance companies and commercial banks came under greater regulatory scrutiny in response to increased loan defaults in the early 1990s, which led to a tightening of standards for real estate loans and a reduction in flexibility on loan terms.
Property values fell, and investors were uncertain of how far values had fallen because so few sales of commercial property were occurring.
The problem was not a lack of potential investors. Although the pension funds had withdrawn from the markets, the core group of real estate developers and professionals involved in the markets before the pension funds entered were still committed to the real estate business and were still willing to commit capital to acquire and control real estate for business investment purposes.
Nor was the problem a lack of potential financing. Despite some withdrawal by savings and loan institutions, insurance companies were still available to provide financing for sound commercial real estate developments. However, there were at least two key constraints on loan commitments by insurance companies that had the practical effect of restricting the amount of available financing.
One key constraint was the emergence of a more strict regulatory environment that restricted the maturities of most loans that insurance companies were willing to make to no more than ten (10) years. This conflicted with the dictates of tax considerations for taxable investors, which suggested that the terms of loans should be at least fifteen (15) years, and preferably twenty (20) years or more.
A second key constraint was that, due to high nationwide vacancy rates in commercial properties, insurance companies were making real estate loans primarily on property that was almost fully leased to tenants that were unlikely to default on their leases. Thus, credit ratings of the tenants were a prime consideration in deciding whether loans should be made.
In fact, insurance companies usually viewed real estate loans as financings of existing tenant leases. Accordingly, lenders usually insisted that property owners assign the rent payments to the lenders to provide additional assurance that loan payments would be made, and lenders also insisted that the rent assignments totally amortize the loans. (The primary reason that most offered mortgages were for no more than ten years was that, in the high-vacancy rental environment existing at that time, most leases ran for no more than ten years.) Furthermore, the lenders could frequently have viewed their legal claims on the tenants' rental payments as perhaps more important than their claims on the property, because in a market with excess space, a claim on vacant space was not particularly valuable.
In other words, during this period of excess rental capacity, financing necessary to sustain the level of liquidity historically experienced by the real estate markets was not available from financial institutions on acceptable terms and conditions.
The result was market “gridlock” and a dearth of real estate transactions until the current economic expansion led to a nationwide increase in demand for rental space and a corresponding decrease in vacancy rates.
Similar troubles have been features of the real estate market at low points in the real estate cycle at various times in the history of the market. Despite great economic pressure to improve the situation, a more efficient technology for real estate finance in an economic environment of excess rental capacity and weak economic activity has not surfaced.
Related problems exist in the case of residential property finance. For example, some homeowners who purchase homes with minimal down payment during real estate booms find themselves forced to own their homes for much longer than desired if their home values fall below the value of the outstanding mortgage debt following the end of the boom. Although home mortgages are legally required to be nonrecourse loans, the problem here is that the federal government views any improvement in personal net worth due to forgiven debt as taxable income. In the case of nonrecourse mortgages, the government considers any transfer of home title from homeowner to mortgage lender to retire mortgage debt as an occurrence of debt forgiveness if the value of the mortgaged property is less than the debt value at the time of the transfer. Consequently, homeowners in such situations who can't afford the tax that would be due upon transfer of title must continue to make their mortgage payments to avoid foreclosure, regardless of whether they would prefer to surrender the property to the lenders and move elsewhere. The problem exists in the case of single-family dwellings such as the following: single-family houses, condominiums (e.g., individually-owned residential units within multifamily residential structures), and single-family residential apartments within multifamily residential cooperatives.
Problems with residential property finance are acute for the more than twenty million Islamic residents of the United States. The Shariah (Islamic religious law) forbids interest-bearing debt as a financing tool. This has long placed Muslims in America who wish to purchase a home but who don't have the resources for an all-cash purchase at a disadvantage. Although lease-based financial instruments have been developed recently by Islamic financial institutions that comply with the Shariah, such instruments cannot be securitized by the financial institutions as would take place routinely in the case of home mortgages. The inability to recycle capital via securitization limits the amount of capital available for such financings and increases the financing cost for homeowners relative to mortgage finance.